Abstract

U.S. policymakers often treat market competition as a panacea. However, in the case of mortgage securitization, policymakers’ faith in competition is misplaced. Competitive mortgage securitization has been tried three times in U.S. history - during the 1880s, the 1920s, and the 2000s - and every time it has failed. Most recently, competition between mortgage securitizers led to a race to the bottom on mortgage underwriting standards that ended in the late 2000s financial crisis. This article provides original evidence that when competition was less intense and securitizers had more market power, securitizers acted to monitor mortgage originators and to maintain prudent underwriting. However, securitizers’ ability to monitor originators and maintain high standards was undermined as competition shifted market power away from securitizers and toward originators. Although standards declined across the market, the largest and most powerful of the mortgage securitizers, the Government Sponsored Enterprises (“GSEs”), remained more successful than other mortgage securitizers at maintaining prudent underwriting. This article proposes reforms based on lessons from the recent financial crisis: merge the GSEs with various government agencies’ mortgage operations to create a single dedicated mortgage securitization agency that would seek to maintain market stability, improve underwriting, and provide a long term investment return for the benefit of taxpayers.

*Winner of the American College of Consumer Financial Services Lawyers (ACCFSL) Writing Award.

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